Charter Reinsurance Company Ltd v Fagan & Ors [1996] UKHL 21

House of Lords
Between
Charter Reinsurance Company LtdAppellantFagan & OrsRespondent
Before
Lord Goff of ChieveleyDate 23 June 1994
LORD GOFF OF CHIEVELEY . My Lords, I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Mustill, and for the reasons he gives I, too, would dismiss this appeal.LORD GRIFFITHS . My Lords, I have had the advantage of reading in draft the speech of my noble and learned friend, Lord Mustill, and for the reasons he gives I, too, would dismiss this appeal.LORD BROWNE-WILKINSON . My Lords, for the reasons given in the speech by my noble and learned friend, Lord Mustill, I, too, would dismiss this appeal.LORD MUSTILL . My Lords, this appeal turns on the meaning of the words "actually paid" in three contracts of reinsurance. The question is whether the words prescribe that no sum will be paid by reinsurer to reinsured in respect of a loss, or more accurately that no sum will be brought into the balance of account between the two parties, until the reinsured has paid out a sum of money to the person whose claim against him has brought the reinsurance into play. At first sight this seems the shortest of questions, requiring a very short answer; and so in the end it proves to be. But the instinctive response must be verified by studying the other terms of the contract, placed in the context of the factual and commercial background of the transaction. I will therefore go straight to the nature of the business and to the terms of the contract in which it was embodied, concentrating for the moment on only one of the three policies, namely policy no. X 20693/5386.By this contract two syndicates, represented in these proceedings by Mr. P. F. Fagan ("the syndicates") reinsured for small percentages of a total line Charter Reinsurance Co. Ltd. ("Charter") in respect of Charter's whole account for losses occurring during the calendar year 1989. The contract formed part of a programme which also comprised "specific reinsurances" taken out with others on four of Charter's accounts viz., non-marine LMX; non-marine international; marine; and aviation. These accounts were reinsured in a series of tranches to limits of, respectively, £23m., £11m., £32.25m. and £31.5m. Above these reinsurances of separate accounts were the levels of whole account reinsurance with which two of the three contracts in suit were concerned. Above a retention of £100,000, there were successive layers of £2.9m., £2m., £2.5m. and £2.5m. Policy no. 5386 insured the second of these layers, for £2m. excess of £3m. and one of the other policies sued upon covered the fourth layer up to £7.5m. For the purposes of the present litigation it is assumed that a series of major casualties arising from perils insured under the policy have caused valid claims to be made against Charter under policies issued by it to other reinsured or insured companies or syndicates ("the inward policies"). These claims are so large as to exhaust all the reinsurances comprising the specific accounts of the programme, and to encroach upon the relevant layers of whole account reinsurance. The problem arises from the fact that Charter is in provisional liquidation, being unable to pay its debts as they fall due, and these debts include claims under the inward policies. For their part, the syndicates do not for present purposes dispute that all the requirements of a valid claim against them by Charter are present, save only one: that Charter have not paid, and cannot pay, the inward claims which they have reinsured. Thus, say the syndicates, Charter have no cause of action under the reinsurance.The practical importance of this defence, if sound, is obvious; and its implications have been multiplied by the levels of financial frailty experienced in the London insurance market in recent years. Across the market as a whole very large sums depend upon it, and the litigation from which this appeal stems has been brought in practice, if not in form, as a test case. The proceedings take the shape of an action by Charter for a summary declaration that payment by way of transfer of funds or other means of satisfaction by Charter under the inward policies was not a condition precedent to the liability of the syndicates. Within avery few months it proved possible to obtain the opinion of the Commercial Court in the shape of a meticulous and thoughtful judgment of Mance J., granting a declaration in those terms. Upon recourse to the Court of Appeal this decision was upheld by a majority, Staughton L.J. dissenting. The syndicates now appeal to this House.This being, I believe, a sufficient summary of the dispute I turn to policy no. X 20693/5386. It is important to quote its terms at some length.For ease of reference I have added numbers and letters, and have placed in italics the words around which the controversy revolves.

"1. Reinsuring clause

"This Reinsurance is to pay all losses howsoever and wheresoever arising during the period of this Reinsurance on any Interest under Policies and/or Contracts of Insurance and/or Reinsurance underwritten by the Reinsured in their Whole Account. Subject however to the following terms and conditions.

"2.(a) Liability clause

"The Reinsurers shall only be liable if and when the Ultimate Net Loss sustained by the Reinsured in respect of interest coming within the scope of the Reinsuring Clause exceeds £3,000,000 or U.S. or Can.$6,000,000 each and every loss and/or Catastrophe and/or Calamity and/or Occurrence and/or Series of Occurrences arising out of one event and the Reinsurers shall thereupon become liable for the amount in excess thereof in each and every loss, but their liability hereunder is limited to £2,000,000 or U.S. or Can.$4,000,000 each and every loss and/or Catastrophe and/or Calamity and/or Occurrence and/or Series of Occurrences arising out of one event.
"(b) Warranted Reinsurers hereon to have benefit of Specific Reinsurances as per Schedule attached.

"Ultimate net loss clause

"(c) The term 'Net Loss' shall mean the sum actually paid by the Reinsured in settlement of losses or liability after making deductions for all recoveries, all salvages and all claims upon other Reinsurances whether collected or not and shall include all adjustment expenses arising from the settlement of claims other than the salaries of employees and the office expenses of the Reinsured. "(d) All Salvages, Recoveries or Payments recovered or received subsequent to a loss settlement under this Reinsurance shall be applied as if recovered or received prior to the aforesaid settlement and all necessary adjustments shall be made by the parties hereto. Provided always that nothing in this clause shall be construed to mean that losses under this Reinsurance are not recoverable until the Reinsured's Ultimate Net Loss has been ascertained.
"(e) Notwithstanding anything contained herein to the contrary, it is understood and agreed that recoveries under all Underlying Excess Reinsurance Treaties and/or Contracts (as far as applicable) are for the sole benefit of the Reinsured and shall not be taken into account in computing the Ultimate Net Loss or Losses in excess of which this Reinsurance attaches nor in any way prejudice the Reinsured's right of recovery hereunder.

"3. Period of reinsurance clause

"This Reinsurance covers Losses Occurring during the period commencing with 1 January 1989 and ending with 31 December 1989 both days inclusive, Local Standard time at the place where the loss occurs. ...

"4. Premium clause

"The Minimum and Deposit Premium for this Reinsurance shall be U.S.$600,000: 10 per cent. Payable in Sterling, namely £37,500; 89½ per cent. Payable in U.S. Dollars, namely $537,000; ½ per cent. Payable in Can. Dollars, namely $3,000 ...

"5. Currency clause

"Losses (if any) paid by the Reinsured in currencies other than Sterling, shall be converted into Sterling at the rate of exchange ruling at the date of the settlement of loss or losses by the Reinsured other than losses paid in U.S. or Can. Dollars which will be paid in those currencies.

"6. Reinstatement clause

"In the event of loss or losses occurring under this Reinsurance, it is hereby mutually agreed to reinstate this Reinsurance to its full amount of £2,000,000 or U.S. or Can.$4,000,000 from the time of the occurrence of such loss or losses to expiry of this Reinsurance and that an additional premium shall be paid by the Reinsured upon the amount of such loss or losses when they are settled in the first instance calculated at 100 per cent. of the Minimum and Deposit Premium hereunder subject to a further payment hereunder (if any) when the Final Earned Premium is known. Reinstatement premiums to be paid in the currency of loss settlement hereunder for which purpose U.S. or Can.$1.60 = £1. Nevertheless the Reinsurers shall never be liable for more than £2,000,000 or U.S. or Can.$4,000,000 in respect of any one loss and/or series of losses arising out of one event, nor for more than £6,000,000 or U.S. or Can.$12,000,000 in all."
The case for the appellants concentrates almost exclusively on the words in italics. It is very simple. These words plainly create a condition precedent to any liability of the syndicates. The condition is that Charter shall have "actually paid" under the original policies. If this expression has a natural and ordinary meaning, effect should be given to it. The expression and the words which comprise it do have such a meaning. By no stretch of language can it be extended to cover a situation in which Charter has not made any disbursement, actual or even notional, and will never do so.My Lords,to a substantial degree I accept this argument. I believe that most expressions do have a natural meaning, in the sense of their primary meaning in ordinary speech. Certainly, there are occasions where direct recourse to such a meaning is inappropriate. Thus, the word may come from a specialist vocabulary and have no significance in ordinary speech. Or it may have one meaning in common speech and another in a specialist vocabulary; and the context may show that the author of the document in which it appears intended it to be understood in the latter sense. Subject to this, however, the inquiry will start, and usually finish, by asking what is the ordinary meaning of the words used. I begin, therefore with "actually." In my opinion this word is used by way of qualification or precaution, in the sense of "really," "in truth," "not notionally" or "not prospectively." On this, I feel no doubts. The word "paid" is more slippery. Unquestionably, it is no longer confined to the delivery of cash or its equivalent. In ordinary speech it now embraces transactions which involve the crediting and debiting of accounts by electronic means, not only transfers between bank accounts by payment cards and direct debits,but also dealings with credit cards and similar instruments. Conditional payment by cheque would also be covered, at any rate outside a strictly legal context. Furthermore, I think it plain that in a document created to govern a transaction in the London insurance market payment would extend beyond remittances from debtor to creditor and would include the settlements in account with brokers which are a feature of that market. None the less, even giving "paid" an extended meaning the word would at first sight, and even without the qualifier "actually," fall well short of encompassing a situation in which the debtor had suffered no immediate financial detriment through a transfer of funds in the direction of the creditor, and would never do so.My Lords,I have used the expression "at first sight" because I had initially thought that the meaning of the words was quite clear, and that the complexities and mysteries of this specialist market had hidden the obvious solution, and had led the courts below to abjure the simple and right answer and to force on the words a meaning which they could not possibly bear. I was not deflected from this opinion by any of the cases cited, which with few exceptions (to which I must return) seemed too remote from the present to offer any useful guidance.This is, however, an occasion when a first impression and a simple answer no longer seem the best, for I recognise now that the focus of the argument is too narrow. The words must be set in the landscape of the instrument as a whole. Once this is done the shape of the policy, and the purpose of the terms which I have grouped as clause 2 become quite clear. As one would expect, four essential features of the insurance are described: the perils insured against; the measure of indemnity; the duration of the cover; and the premium. Clause 1, read together with various later clauses of enlargement and restriction, which I have not quoted, describes the nature and geographical scope of the perils insured against. In principle, all events happening within the period laid down by clause 3 (construed in association with special provisions relating to liability insurance) which constitute losses by perils insured under the original policies are to be losses insured under this policy. This is not the place to discuss the question, perhaps not yet finally resolved, whether there can be cases where a contract of reinsurance is an insurance of the reinsurer's liability under the inward policy or whether it is always an insurance on the original subject matter, the liability of the reinsured serving merely to give him an insurable interest. This may be important in the context of regulation, but it makes no difference here, for it is quite plain that payment by reinsurer is not the insured event. There has still been an insured loss, and even if the argument for the syndicates is right the consequence is only to reduce or eliminate the amount of Charter's recovery under clause 2 in respect of a loss which has undoubtedly occurred. Clause 1 therefore has no bearing on the present dispute. Nor of course is the premium provision in clause 4 of any relevance.What does matter is the group of provisions which establish the measure of indemnity, once a loss by an insured peril has taken place. I would break these down as follows.(i) Clause 2(a) fixes the level at which financial prejudice suffered by Charter under the inward policies in consequence of a loss by a peril insured under this policy causes a liability to attach. This happens when the ultimate net loss in relation to each and every loss and/or catastrophe and/or calamity and/or occurrence (which I will call a set of linked losses) exceeds £3m. This sub-clause also fixes the upper limit of indemnity under the policy. An additional limit, this time fixed by reference not to each set of linked losses but to the cover for the entire policy year, is imposed by the last sentence of clause 6.(ii) Clause 2(b) incorporates into the scheme of the policy the four sets of layered "specific" insurances (i.e. the "accounts") identified in the schedule. When an event occurs which is a peril insured under one of those sets of insurances and also under this policy the limits of all the insurances comprising that account must be exceeded before any indemnity begins to fall due under this policy.(iii) Clause 2(c) gives meaning to clause 2(a) by defining ultimate net loss. (In fact the sub-clause omits "ultimate." This must be a mistake, for otherwise the entire group of provisions makes no sense. The word does appear in the clause as typed in the aviation policy). The purpose of clause 2(c) is to make clear that the syndicates are not to pay losses gross, but that there is to be a netting-down for recoveries, salvage and the like when ascertaining whether, and if so by how much, the relevant liabilities of Charter cross the boundary into the layer covered by this policy.(iv) The first sentence of clause 2(d) elaborates clause 2(c) by making clear that the fixing of an ultimate net loss in respect of any set of linked losses is provisional, in the sense that the amount of it, and hence its impact if any on this layer of insurance, is to be open to recomputation if

[1997] A.C. 313 Page 386

and when items of the identified description subsequently accrue to the benefit of Charter.(v) The proviso in the second sentence of clause 2(d) emphasises that even though the computation of an ultimate net loss is provisional, if it yields a figure broaching the bottom of the layer insured under this policy it will then be "recoverable" even if a subsequent recalculation when all the figures are in may lead to an upward or downward adjustment, or even to the elimination of any recovery at all.(vi) Clause 2(e) is puzzling at first sight, because the use of initial capitals may suggest that, like "Specific Insurances" in clause 2(b), the expression "Underlying Excess Reinsurance Treaties and/or Contracts" has a meaning specifically ascribed for the purpose of this policy. Yet one finds it nowhere defined. In fact, however, a reading of the document as a whole shows that capitals are used indiscriminately throughout, and that they have no special significance in clause 2(e). In the light of the explanations given in argument, I accept that the purpose of the sub-clause is simply to ensure that the calculation of the ultimate net loss under sub-clause (a) does not involve a deduction of the liabilities on the underlying layers, so as to diminish the possibility of a recovery on the layer covered by this policy.Analysed in this way, the policy makes complete sense, and works perfectly well in practice when understood as requiring the satisfaction of only two conditions before an indemnity falls due. First, that an insured event shall have occurred within the period of the policy, and second that the event shall have produced a loss to Charter of a degree sufficient, when ultimately worked out, to bring the particular layer of reinsurance into play. This reading accommodates without strain the words "if and when," in clause 2(a); for they are concerned only with the point, not of time but of arithmetic, at which the figures for the ultimate net loss reach the appropriate level. Equally, I am now satisfied that the purpose of "the sum actually paid" in clause 2(c) is not to impose an additional condition precedent in relation to the disbursement of funds, but to emphasise that it is the ultimate outcome of the net loss calculation which determines the final liability of the syndicates under the policy. In this context, "actually" means "in the event when finally ascertained," and "paid" means "exposed to liability as a result of the loss insured under clause 1." These are far from the ordinary meanings of the words, and they may be far from the meanings which they would have had in other policies, and particularly in first-tier policies of reinsurance. But we are called upon to interpret them in a very specialised form of reinsurance, and I am now satisfied that, as Mance J. expressed it in his judgment at first instance, the words in question did not have the purpose of introducing a temporal precondition to recovery in the form of disbursement or other satisfaction of the precise net commitment between Charter and its reinsured, but were there "for the purpose of measurement."Whilst I have come to this conclusion simply from a study of the document I ought to comment on a number of other matters which are said to bear upon it. In the first place, there is an argument ad absurdum to the effect that the parties cannot have intended Charter to retain such liquidity as would enable it to answer claims under the incoming policies without recourse to the reinsurance. At a time when the use of money was a vital element in the profitability of insurance business it is impossible to suppose (the argument runs) that Charter should have agreed to finance its own outlays, the more so since, if the syndicates' interpretation of clause 2 is right, Charter would have to find, not only the funds required to disburse the sum due under this particular layer, but also the total of the underlying reinsurances. This would be a wholly impracticable arrangement, and would bear especially hard on Charter if it fell into financial trouble and lacked the means to make the payments necessary to unlock the reimbursements due under its contracts with the syndicates.This argument draws strength from the shape of the policy. As I have already suggested, under this form of words, although perhaps not under all forms, the policy covers not, as might be thought, the suffering of loss by the reinsured in the shape of a claim against him under the inward policies, but the occurrence of a casualty suffered by the subject-matter insured through the operation of an insured peril. The inward policies and the reinsurance are wholly distinct. It follows that in principle the liability of the reinsurer is wholly unaffected by whether the reinsured has satisfied the claim under the inward insurance: see, amongst several authorities, In re Eddystone Marine Insurance Co.; Ex parte Western Insurance Co. [1892] Ch. 423. This result can undoubtedly be changed by express provision, but clear words would be required; and it would to my mind be strange if a term changing so fundamentally the financial structure of the relationship were to be buried in a provision such as clause 2, concerned essentially with the measure of indemnity, rather than being given a prominent position on its own.Further arguments, to my mind some way short of conclusive, were advanced on each side. The syndicates pointed out a possible disconformity between the postponement of the reinsurers' liability to pay with the statutory provisions governing margins of solvency. For Charter attention was drawn to long-established contractual provisions creating just such a condition precedent as is argued for here: for example, in the running down clause and in protection and indemnity club cover against third party liabilities, the effect of which was discussed in Firma C-Trade S.A. v. Newcastle Protection and Indemnity Association [1991] 2 A.C. 1. Each side suggested reasons why such a provision would or would not make commercial sense; and proposed ways in which the hardship to the reinsured might be ameliorated by devices such as the making of a series of small "pump priming" payments, which would produce a sufficient trickle of cash to satisfy ultimately the inward claim in full, hence unlocking a recovery under the reinsurance.These arguments are fully explored in the judgments delivered below. Intending no disrespect I do not enter into them here, for in my opinion they cannot be decisive. If, as I believe, a proper reading of the policy discloses no condition precedent, there is little profit in considering whether it would have been absurd to include one. If, per contra, the words "actually paid" can only as a matter of language and context mean what the syndicates maintain, I would hesitate long before giving them any other meaning, just because the result would be extraordinary. The words of Lord Reid in Wickman Machine Tool Sales Ltd.v. Schuler A.G. [1974] AC 235 , 251 do, of course, reflect not only a method of constructing contracts but also the common experience of how language is understood:
"The fact that a particular construction leads to a very unreasonable result must be a relevant consideration. The more unreasonable the result the more unlikely it is that the parties can have intended it, and if they do intend it the more necessary it is that they shall make that intention abundantly clear."
This practical rule of thumb (if I may so describe it without disrespect) must however have its limits. There comes a point at which the court should remind itself that the task is to discover what the parties meant from what they have said, and that to force upon the words a meaning which they cannot fairly bear is to substitute for the bargain actually made one which the court believes could better have been made. This is an illegitimate role for a court. Particularly in the field of commerce, where the parties need to know what they must do and what they can insist on not doing, it is essential for them to be confident that they can rely on the court to enforce their contract according to its terms. Certainly, if in the present case the result of finding a condition precedent would be anomalous there would be good reason for the court to look twice, and more than twice, at the words used to see whether they might bear some other meaning. In the end, however, the parties must be held to their bargain. Thus,if I had adhered to my first impression that the expression "actually paid" could possess, even in the context of the policy, only the meaning which it has in ordinary speech I would have wished to consider very carefully whether the opinion expressed in the dissenting judgment of Staughton L.J., austere as it might seem, ought to be preferred. In the event however, for the reasons stated, this is not my present understanding of the words, and since the broader question does not on this view arise I prefer to say no more about it.Next, I must notice three decisions from the United States. The first is Allemannia Insurance Co. of Pittsburgh v. Firemen's Insurance Co. of Baltimore (1908) 209 U.S. 326. A proportionate policy of reinsurance stipulated (p. 328) that:
"11. Each entry under this compact ... shall be subject to the same conditions, stipulations, risks and valuations as may be assumed by the said reinsured company under its original contracts hereunder reinsured, and losses, if any, shall be payable pro rata with, in the same manner, and upon the same terms and conditions as paid by the said reinsured company under its contracts hereunder reinsured, and in no event shall this company be liable for an amount in excess of a ratable proportion of the sum actually paid to the assured or reinsured ..."
After the great fire in Baltimore of 1904 the direct insurer became insolvent and could not pay more than 55 cents in the dollar, and therefore was unable to satisfy claims under its policies unless it could first recover from the reinsurer. The Supreme Court of the United States held that payment by the reinsured was not a condition of recovery under the reinsurance. Delivering the opinion of the court Peckham J. stated, at p. 336:
"We agree with the court below, that the language of the eleventh subdivision, taken in connection with the fact that it is used in a contract designated by the parties as one of reinsurance, means that the reinsuring company shall not pay more than its ratable proportion of the actual liability payable on the part of the reinsured, after deducting all liability of other reinsurers. To hold otherwise is to utterly subvert the original meaning of the term reinsurance and to deprive the contract of its chief value. The losses are to be payable pro rata with, in the same manner and upon the same terms and conditions as paid by the reinsured company under its contracts. This means that such losses, payable pro rata, are to be paid upon the same condition as are the losses of the insurer under its contract. ... [This] ... does not mean there must be an actual payment of such liability by the insurer before it can have any benefit of the contract of reinsurance which is made with defendant."
In the second case, Fidelity & Deposit Co. v. Pink (1937) 302 U.S. 224 the contract was in very different terms. It stipulated that the reinsurer's proportionate share of the loss should be paid to the reinsured upon proof of payment by the reinsured, and on tender of documents in support. It was furthermore stipulated that the reinsured might give the reinsurer prospective notice of its intention to pay on a certain date, and might require the reinsurer to put its share of the loss in the hands of the reinsured by that date. Distinguishing the Allemannia case, without differing from the statement of general principle therein contained, the Supreme Court held that on this occasion the contract was effective to make prior payment a condition precedent to liability.Finally, in Stickel v. Excess Insurance Co. of America (1939) 23 N.E.2d 839, an ultimate net loss clause defined that term (p. 841) as "the sum actually paid in cash in settlement of losses for which the company is liable, after making proper deductions ..." Founding on the language of the particular policy in question, the Supreme Court of Ohio found the case closer to Pink than to Allemannia, and held that once again actual disbursement was a condition precedent to recovery.There was some suggestion in argument that there is an inconsistency between these cases. On examination I can detect none. Even the brief account given above is sufficient to make the individual decisions perfectly understandable. Whether they were all right it is unnecessary and inappropriate to consider; and it is of course true that the Allemannia case, 209 U.S. 326 was concerned with proportionate insurance, whereas the present is not. What it is permissible to say however is that the brief statement of general principle in that case accords with the law as it has been understood for many years, in common law jurisdictions and elsewhere. I can see nothing in these cases to cast doubt on the opinion which I have expressed as to the effect of the present policy.Finally, there are the inferences about the purpose of the words "actually paid" which may be drawn from the history of the "follow settlements" clause. The matter is fully developed in the speech of my noble and learned friend, Lord Hoffmann. If I own to hesitation in adopting this as a direct answer to the problem it is because the historical materials presented in argument are incomplete, and subsequent reading has not filled the gaps. It is however clear that in the long time-frame of the insurance industry excess of loss reinsurance is comparatively modern, probably dating from transactions arranged by C.E. Heath in the United States in the last two decades of the 19th century. It was not until after the Baltimore fire that the need for an excess of loss non-proportionate cover written on a treaty basis became obvious. Such cover would of course need to provide for a means of ascertaining the point at which the reinsurance (or its first layer) attached; equally important however, was that this determined the amount of the reinsured's retention, always a matter of prime importance when writing reinsurance. I think it a reasonable surmise that this retention was expressed in terms of net rather than gross. It is likely therefore that there was from the start some form of ultimate net loss clause in American excess of loss policies. Given that the Allemannia proportional reinsurance, effected in 1903, already included these words, I think it as likely that they were simply copied into excess of loss policies, as that they were deliberately included to combat a puzzling English decision some 20 years old, not referred to at all in the report of the Allemannia case, and not yet the subject of acute controversy even in England. This is however surmise but it is possible to say with some confidence that there is nothing in the available history to suggest that the words "actually paid" were and are included in order to create a condition precedent.There is one final point, directed to the wording of this particular policy. It will be recalled that clause 2(c) defined net loss as "the sum actually paid ... after making deductions for all recoveries [etc] whether collected or not." There is a discontinuity here, if the syndicates are right. There is good reason why the provisional ascertainment of the effect which the losses will have on the reinsured layer should be made in the light of forecasts about the funds which will be transferred out, and the funds which will be transferred in, on future occasions before the ultimate net loss is finally ascertained, but I can see no reason why uncollected funds should be used as a contra sum at a time when through the absence of payment under the inward policies there is nothing against which to set them. Here again, I do not regard the point as conclusive, but it does reinforce the solution at which I have independently arrived.For these reasons therefore I consider that the interpretation given by Mance J., and Simon Brown L.J. to policy no. X 20693/5386 was correct. This makes it unnecessary to consider the alternative line of reasoning which led Nourse L.J. to conclude in favour of Charter. The position under the second policy is acknowledged to be the same.There remains the aviation policy. There are differences between this and the first two policies which might for other purposes be important. Mance J. has drawn attention to some of them. But in my opinion none of them bear on the present dispute, and the reasoning which I have proposed applies equally to all three contracts.In these circumstances I would dismiss the appeal.LORD HOFFMANN . My Lords, this appeal turns upon the construction of a standard clause known as the ultimate net loss ("U.N.L.") clause which is in common use in the London excess of loss reinsurance market. Although the action concerns three particular policies of reinsurance written on behalf of two Lloyd's syndicates, it raises an issue which affects the whole reinsurance market.The relevant provisions are set out in the speech of my noble and learned friend, Lord Mustill, and I need not repeat them. The question is whether the words "actually paid" mean that the liability of the reinsurers is limited to the sum in respect of which Charter Reinsurance has discharged its liabilities in respect of the risks which it insured. Mr. Sumption says that this is the natural meaning of the words. There is nothing in the context which requires them to be given a different meaning and that is the end of the matter.I think that in some cases the notion of words having a natural meaning is not a very helpful one. Because the meaning of words is so sensitive to syntax and context, the natural meaning of words in one sentence may be quite unnatural in another. Thus a statement that words have a particular natural meaning may mean no more than that in many contexts they will have that meaning. In other contexts their meaning will be different but no less natural.Take, for example, the word "pay." In many contexts, it will mean that money has changed hands, usually in discharge of some liability. In other contexts, it will mean only that a liability was incurred, without necessarily having been discharged. A wife comes home with a new dress and her husband says "What did you pay for it" She would not be understanding his question in its natural meaning if she answered "Nothing, because the shop gave me 30 days' credit." It is perfectly clear from the context that the husband wanted to know the amount of the liability which she incurred, whether or not that liability has been discharged.What is true of ordinary speech is also true of reinsurance. In re Eddystone Marine Insurance Co.; Ex parte Western Insurance Co. [1892] 2 Ch 423 the policy contained the form of reinsurance clause then in common use "and to pay as may be paid thereon." As in this case, the reinsured company was in insolvent winding up and could not pay its debts. Stirling J. said, at p. 427, that the policy did not mean that the liability should have been discharged. They meant only that "the payment to be made on the reinsurance policy is to be regulated by that to be made on the original policy of insurance." In other words, the clause is concerned with the amount of liability and is indifferent to whether or not it has been discharged.But, said Mr. Sumption, there is the word "actually." Stirling J. might have been willing to accept that paid could in some artificial or figurative sense mean "liable to be paid." But the word "actually" was surely added to make it clear that money must have changed hands. "Actually paid" said Mr. Sumption, meant actually paid.One speaks of something being "actually" the case to point a contrast; perhaps with what appears to be the case, or with what might be the case, or with what is deemed to be the case. The effect of the word therefore depends upon the nature of the distinction which the speaker is wanting to make. This can appear only from the context in which the phrase is used. It is artificial to start with an acontextual preconception about the meaning of the words and then see whether that meaning is somehow displaced. The context might indicate that the word was used to reverse the ruling in the Eddystone case and require the liability of the reinsured to have been discharged. On the other hand, it might suggest that a different contrast was intended.To revert to my domestic example, if the wife had answered "Well, the dress was marked £300, but they were having a sale," and the husband then asked "So what did you actually pay" she would again be giving the question an unnatural meaning if she answered "I have not paid anything yet." It is obvious that the contrast which the husband wishes to draw is between the price as marked and the lower price which was charged. He is still not concerned with whether the liability has been discharged. This is not a loose use of language. In the context of the rest of the conversation, it is the natural meaning.What then is the context Is the draftsman wanting to draw a contrast with the meaning given to "paid" in the Eddystone case [1892] 2 Ch 423 or does he have some other contrast in mind My noble and learned friend, Lord Mustill, has analysed the structure of the policies and for the reasons which he gives, I agree that the context points to a wish to emphasise the net character of the liability as opposed to what, under the terms of the policies, the liability might have been.I think that these conclusions are reinforced by the history of reinsurance clauses. Contracts of reinsurance were unlawful until 1864. Such a contract is not an insurance of the primary insurer's potential liability or disbursement. It is an independent contract between reinsured and reinsurer in which the subject matter of the insurance is the same as that of the primary insurance, that is to say, the risk to the ship or goods or whatever might be insured. The difference lies in the nature of the insurable interest, which in the case of the primary insurer, arises from his liability under the original policy: see Buckley L.J. in British Dominions General Insurance Co. Ltd. v. Duder [1915] 2 K.B. 394, 400.The difference in the nature of the insurable interest does however mean that, insurance being a contract of indemnity, the amount recoverable will not necessarily be the same as under the primary insurance. For example, the liability of the primary insurer will not necessarily be for the whole loss suffered by the original insured but may be subject to exceptions and limitations. His net outlay can also be reduced by recoveries underhis right of subrogation. It therefore became customary in the market to have a special clause or clauses which defined the extent of the reinsurer's liability. It appears that the most commonly used form in the early years of reinsurance was to add the words "Being a reinsurance, subject to all clauses and conditions of the original policy or policies, and to pay as may be paid thereon:" see McArthur, The Contract of Marine Insurance, 2nd ed. (1890), p. 332 and the form of policy in Uzielli & Co. v. Boston Marine Insurance Co. (1884) 15 Q.B.D. 11, 12.As construed by the courts, however, the phrase "and to pay as may be paid thereon" disappointed the expectations of the market on both sides. The original insurers assumed that it meant that if they agreed in good faith to pay under the original policy, they would be able to recover without having to prove their own legal liability. Reinsurers assumed that whatever the loss of the original insured might be, their liability would not exceed the net outlay of the reinsured, after taking all recoveries into account. Both assumptions were to prove false.The story of how the expectations of original insurers were disappointed by the decision of Mathew J. in Chippendale v. Holt (1895) 1 Com.Cas. 197 and the subsequent development of the "follow settlements" clause to restore what had been thought to be the effect of the old clause has been told more than once, including by Scrutton L.J., who was junior counsel in Chippendale v. Holt, in Gurney v. Grimmer (1932) 44 Ll.L.R. 189, 192-194. (For subsequent developments, see Robert Goff L.J. in Insurance Co. of Africa v. Scor (U.K.) Reinsurance Co. Ltd. [1985] 1 Lloyd's Rep. 312.)The second assumption, on the part of reinsurers, had however been shaken by an even earlier decision. In Uzielli & Co. v. Boston Marine Insurance Co., 15 QBD 11 the defendants were reinsurers of the reinsurers of the Rose Middleton, which had been insured in the sum of £1,000. The ship went aground and the owners gave notice of abandonment to the original underwriters. The underwriters disputed the validity of the notice but eventually settled the claim for 88 per cent. But they also spent more money in getting the ship off the rocks than they eventually realised in selling her. The result was that they incurred a total loss of 112 per cent. They recovered the additional sum from the plaintiffs, their reinsurers, under a "sue and labour" clause in the policy which entitled them to recover such expenditure reasonably incurred by the insurers or their "factors or servants or assigns." The plaintiffs in turn claimed £1,120 from the defendants. Matthew J. held that there had been a constructive total loss, that the reinsurers were entitled to add the expenditure of the underwriters on salvage under the "sue and labour" clause and gave judgment for £1,120. The reinsurers appealed and the Court of Appeal held that, as against the defendants, the "sue and labour" clause did not cover expenditure by the original underwriters because they were not the "factors or servants or assigns" of the first reinsurers. One might have thought that the result would be that the plaintiffs could recover only the 88 per cent. of the £1,000 for which the claim of the shipowner had been settled. That was what had been paid on the original insurance policy. Instead, however, the court substituted a judgment in favour of the underwriters for £1,000.The Uzielli case caused a good deal of puzzlement in the market and among marine insurance lawyers. Mr. McArthur (The Contract of Marine Insurance, p. 335) said that "as the facts in the case were peculiar, no general principle can be deduced from the decision." In Western Assurance Co. of Toronto v. Poole [1903] 1 KB 376 , 387-388, Mr. Hamilton K.C. and Mr. Scrutton K.C. offered Bigham J. different explanations of the case, neither of which he found satisfactory. In British Dominions General Insurance Co. Ltd. v. Duder [1915] 2 K.B. 394, Buckley L.J. said that he could not find any principle in the case: p. 402. Pickford L.J. likewise said, at p. 405, that it was very hard to understand and Bankes L.J. was similarly perplexed: see p. 413. Although the principle of indemnity is fully reaffirmed in Duder it would not be surprising if the market felt nervous that the House of Lords might one day see some light in Uzielli which had eluded other judges since the time it was decided.Although the commercial history of the matter is not as well documented as that of the "follow settlements" clause, it is clear that the formula "pay as may be paid thereon" disappeared from standard forms of reinsurance. The objects which it had sought to achieve on behalf of the original insurers were taken over by the follow settlements clause. It does not seem unreasonable to infer that its function in delimiting the liability of the reinsurers was taken over by the ultimate net loss clause. The U.N.L. clause shows throughout a preoccupation with ensuring that the reinsurer cannot be called upon to pay more than the reinsured has been required to pay. In Uzielli the words "pay as may be paid" had proved ineffective to achieve this result, even though they had been thought apt to do so. In his argument in Duder's case [1915] 2 K.B. 394, 398 Mr. Roche K.C., arguing for a similar result to that in Uzielli, said plaintively but truthfully, that the words "pay as may be paid thereon:
" "weakened the case of the plaintiffs, and yet this court held that they could recover the full 100 per cent. and not merely the 88 per cent. for which they had settled the claim against them."
It would not therefore be surprising if underwriters thought that if "paid" was not good enough to satisfy the courts, "actually paid" might drive the point home.The U.N.L. clause in the policies before the House has been traced back in unaltered form to the early 1930s and I would not be surprised if it went even further back than that. The words "actually paid" can be found in the policy considered in Allemannia Insurance Co. of Pittsburgh v. Firemen's Insurance Co. of Baltimore, 209 U.S. 326, where they were given the construction which I suggest in this case.I find further support for my view in the fact that the U.N.L. clause has been thought suitable for use in the London excess of loss reinsurance market. There are certainly forms of reinsurance in which it may be commercially appropriate to make discharge of his liability by the reinsured a condition of the liability of the reinsurer. It may be, as in cases of mutual insurance, that the reinsurer has an interest in making certain that the reinsured maintains sufficient liquid assets to meet his liabilities. Or it may be a protection against fraudulent claims. But the London excess of loss market operates on the assumption that a reinsurance programme will relieve the insurer of the burden of having to pay claims covered by the reinsured layers. The regulation of insurers in this country uses a test of solvency which treats reinsurance cover as a proper deduction from the insurer's liabilities. None of this would make sense if the insurer had first to satisfy the claim out of his own resources before he could call upon his reinsurers to pay.Mr. Sumption suggested a stratagem which insurers might use to avoid having to pay the whole claim themselves. They could pay a part, even a very small part, of the reinsured liability and then, having to this extent actually paid, they could call upon the reinsurer to reimburse them. Having thus primed the pump, they could by successive strokes draw up the full amount from the reinsurance well. I cannot imagine that the parties could ever have contemplated such a strange procedure and one is bound to ask what commercial purpose the reinsurer could have expected to achieve by being able to insist upon it.Considerations of history, language and commercial background therefore lead me to the conclusion that the word "actually" in the U.N.L. clause is used to emphasise that the loss for which the reinsurer is to be liable is to be net and that the clause does not restrict liability to the amount by which the liability of the reinsured for the loss has been discharged. I think that this is the natural meaning of the clause.In conclusion I would like to pay tribute to the judgment of Mance J. which deals comprehensively with the issues and all the relevant authorities and with which I am in full agreement. I would dismiss the appeal.Appeal dismissed.No order as to costs.